Ukrainian Academy of Banking Banking Department Course: Banking

1. Ukrainian Academy of Banking Banking Department Course: Banking Lecture 3 Bank borrowed funding Anna Vladimirovna Buriak

2. Game: “Translating words” 2 groups of people with their leaders

3. Agenda 1. Borrowed deposit funding (retail) 2. Borrowed non-deposit funding (wholesale) 3. Off-balance sheet activity

4. Types of bank funds Themainsourceofbankfunds areborrowedfunds, whoseshareinthebankingsystemaverageof 80% ofthetotalfunds, andtherest (20%) areinown funds.

5. Active vocabulary • Deposit account (Britain) = Savings Account (America) • Current (demand) deposit (Britain) = Checking Account (America) • Money market deposit account (MMDA) • Certificate of deposit (CD) • Statement savings • To make a deposit (place money on deposit) • Annual percentage yield

6. One of the main banking activities is acceptance of deposit from the public for the purpose of lending to businessmen and others who may need loans.

7. Bank deposits serve different purposes for different people: • Some people cannot save regularly - • they deposit money in the bank only when they have extra income. The purpose of deposit then is to keep money safe for future needs. • Some may want to deposit money in a bank for as long as possible to earn interest or to accumulate savings with interest so as to buy a flat etc. • Keeping in view these differences, banks offer the facility of opening different types of deposit accounts by people

8. Bank deposit accounts may be classified as follows: • Savings Bank Account • Current Deposit Account • Fixed Deposit Account • Money Market Deposit Account

9. Savings Bank Account • If a person has limited income and wants to save money for future • needs, the Saving Bank Account is most suited for his purpose. • This type of account can be opened with a minimum initial deposit that varies from bank to bank. • Money can be deposited any time in this account. • Withdrawalscan be made either by signing a withdrawal form or by • issuing a cheque or by using ATM card. Normally banks put some restriction on the number of withdrawal from this account. • The rate of interest on savings bank account varies from bank to bank and also changes from time to time. • A minimum balance has to be maintained in the account as prescribed by the bank.

10. Current Deposit Account • Big businessmen, companies and institutions have to make payment through their bank accounts. Since there are restriction on number of withdrawals from savings bank account, that type of account is not suitable for them. They need to have an account from which withdrawal can be made any number of times. • Banks open current account for them. • This account also requires certain minimum amount of deposit while opening the account. • On this deposit bank does not pay any interest on the balances. • For the convenience of the accountholders banks also allow withdrawal of amounts in excess of the balance of deposit. This facility is known as overdraft facility. It is allowed to some specific customers and up to a certain limit.

11. Fixed Deposit Account (also known as Term (Time) Deposit Account) Many a time people want to save money for long period. If money is deposited in savings bank account, banks allow a lower rate of interest. Therefore, money is deposited in a fixed deposit account to earn a interest at a higher rate. This type of deposit account allows deposit to be made of an amount for a specified period. This period of deposit may range from 15 days to three years or more during which no withdrawal is allowed.

12. Money Market Deposit Account A money market deposit account is a type of deposit account that offers a relatively high interest rate. Money market accounts are similar to savings accounts, but : Where savings accounts usually have a fixed interest rate, these accounts have rates that vary regularly based on money markets. Instead of using these deposits to fund mortgages and other credit instruments, banks reinvest your savings into traditionally secure, short-term holdings. Many money market accounts require initial deposits of $2,500 or more. Although some banks allow new customers to start accounts with as little as $1,000, minimum balance amounts may also apply, which can quickly negate the extra dividends from your higher interest rate.

13. Money Market Deposit Account • Money market accounts may appeal to depositors who: • Can afford to start an account with more than $2,500 • Intend to keep a sizable balance in the account • Enjoy the flexibility of writing some checks from the account • Require regular access to their funds

14. Agenda 1. Borrowed deposit funding (retail) 2. Borrowed non-deposit funding (wholesale) 3. Off-balance sheet activity

15. BANK LIABILITIES WHOLESALE (NON-DEPOSITS) RETAIL (DEPOSITS) BANK EQUITY

16. WHOLESALE (NON-DEPOSITS) BANK FUNDING • unpersonalnature - they are not associated with a specific customer of the bank and bought in the market (from other financial institutions, non-financial corporations, state and local authorities, and foreign entities); • initiative for fund raising belongs to the bank; • usually used by large banks; • usually short-term.

17. WHOLESALE (NON-DEPOSITS) BANK FUNDING • “bright side” • usage of investment opportunities; • security from unexpected retail withdrawals • “dark side” • transmission of shocks throughout the financial system; • bank relies on short-term wholesale funds to support long-term illiquid assets

18. Daniel Tarullo (member of the Board of Governors of the United States Federal Reserve Board) “Short-term wholesale funding plays a critical role in the financial system. During normal times, it helps to satisfy investor demand for safe and liquid investments, lowers funding costs for borrowers, and supports the functioning of important markets… During periods of stress, however, runs by providers of short-term wholesale funding and associated asset liquidations can result in large fire sale externalities and otherwise undermine financial stability.”

19. UKRAINE WHOLESALE (NON-DEPOSITS) BANK FUNDING Loans from other banks Funds of investors Loans from the central bank

20. Terms of receiving - from a few days to 3-6 months. The main purpose of obtaining interbank credit: - maintain current liquidity - expansion of active operations. Loans from other banks

21. obtaining loans from the National Bank of Ukraine on various refinancing procedures. Loans from the National bank of Ukraine

22. Bonds issue – banks have the right to issue bonds in an amount not greater than 3-fold the size of their. !!! It is forbidden to issue bonds for the share capital formation and to cover losses from business activities. Funds of investors

23. Interbank lending market • The interbank lending market refers to the money market • (over-the-counter (OTC) market). • The interbank lending market is a market in which banks make loans to one anotherfor a specified term. • Most interbank loans are for maturities of one week or less, the majority being overnight. • Funds are transferred through the purchase and sale of money market instruments— highly liquid short-term debt securities. • Banks are required to hold an adequate amount of liquid assets, such as cash, to manage any potential bank runs by clients. If a bank cannot meet these liquidity requirements, it will need to borrow money in the interbank market to cover this. Some banks, on the other hand, have excess liquid assets above and beyond the liquidity requirements. These banks will lend money in the interbank market, receiving interest on the assets.

24. Interbank lending market • Such loans are made at the interbank rate (also called the overnight rate if the term of the loan is overnight). • The interbank rate is the rate of interest charged on short-term loans between banks. • The interest rate charged depends on the availability of money in the market, on the specific terms of the contract, such as term length. • There is a wide range of published interbank rates, including the federal funds rate (USA), the LIBOR (UK) and the Euribor (Eurozone).

25. The National Bank of Ukraine as main regulator can influence on the scope of activity, liquidity and other indicators of banks. • Thus, the NBU enters the credit market with the following objectives: • Regulation of bank liquidity in Ukraine; • Providing stabilization loans to support and financial rehabilitation of banks; • Maintaining macroeconomic stability.

26. National Bank to regulate liquidity banks act as lender of last resortusethe following tools: • refinancing operations (permanent line to provide refinance to banks for overnight loans, refinancing loans); • repos transactions (transactions direct repo, reverse repo transactions); • activity with their own debt obligations (certificates of deposit overnight and up to 90 days); • activity with government bonds of Ukraine.

27. Agenda 1. Borrowed deposit funding (retail) 2. Borrowed non-deposit funding (wholesale) 3. Off-balance sheet activity

28. Bank balance sheet is a statement of its assets and liabilities.

29. Off-balance sheet activity? It’s special type of bank activities. They represent the operations which are not seen in the bank balance sheet. But…in fact… Some of the OBS activities are evidenced simultaneously in the balance sheet and off-balance sheet. * The typical examples are futures, forwards or options. These derivative instruments are recorded in the balance sheet in their real value and in the off-balance sheet in their nominal value.

30. As the off-balance sheet activities are future potential balance sheet assets, they are connected with a certain level of credit risk. After the off-balance sheet asset transforms into the balance sheet asset, there is a probability that the counterpart will not fulfill its obligation (e.g. pays his debt).

31. The meaning of the balance-sheet activity • off-balance sheet fee (income) producing activities can improve earnings ratios, at a faster pace than on-balance sheet fee producing activities. • 2. Because these types of activities remain off the balance • sheet, capital to asset ratios (with the exception of risk-based • capital ratios) are not adversely affected regardless of the volume of business conducted. But, the volume and riskof the off-balance sheet activities needs to be considered by the examiner in the evaluation of capital adequacy.

32. What does off-balance sheet activity include? • loan commitments; • letters of credit; - swaps, futures, forwards, and option contracts

33. OFF-BALANCE SHEET LENDING ACTIVITIES 1. Letter of credit - document issued by a bank on behalf of its customer authorizing a third party to draw drafts on the bank up to a stipulated (оговоренный)amount and with specified termsand conditions. The letter of credit is a conditionalcommitment onthe bank’s part to provide payment on drafts drawn inaccordance with the document terms. The two primary areas of risk relative to LCs are credit risk (the possibility of default on the part of the account party), and funding risk (the potential inability of the bank to fund a large draw from normal sources).

34. OFF-BALANCE SHEET LENDING ACTIVITIES • Bank loan commitments: • Promise by a bank to a customer to make a future loan under certain conditions. Most commercial and industrial loans are made under some form of guarantee (informal or formal). Line of credit -- Informal commitment of a bank to lend funds to a client firm. Revolving line of credit -- Formal agreement by a bank to lend funds on demand to a client firm under the terms of the contract. Bank is exposed to interest rate risk. Funding risk-- Risk that many borrowers will take down commitments at the same time and thereby strain bank liquidity.

35. OFF-BALANCE SHEET LENDING ACTIVITIES • Derivatives: • Swaps, options, futures, forward contracts, and securitized assets. • Regulators (including the Commodity Futures Commission, SEC, Federal Reserve, OCC, and FDIC) are very concerned with derivative exposures of banks (e.g., liquidity, fraud, human risks).

36. Other off-balance sheet activities • Loan sales: • Banks can sell loans to a third party as a source of funds. For a fee the selling bank often continues to service the loan payment and handle other responsibilities of the loan. • Allows banks to make loans without relying on deposits and converts traditional lending to a quasi-securities business. • On the other hand, other buying institutions become more like banks. • Securitization • financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations and selling consolidated debt as bonds, pass-through (вторичные)securities, or collateralized mortgage obligation (CMOs), to various investors.